Deductions, Tax Credits, and Government Subsidies for Health Care

What does it all mean? Judging from comments on previous items here, there is much confusion about this terminology and how it impacts health coverage for small business owners. I’ll try to clarify the tax breaks; forgive me if I oversimplify.

Deductions

Deductions are merely subtractions that reduce the amount of income that’s taxed. They save you taxes, but the amount of savings depends on your tax bracket. For example, if you’re in the 25% tax bracket, a $1,000 deduction saves you $250 ($1,000 x 25%).

For health care purposes, there are three types of deductions:

Subtractions from business income. This category covers premiums paid for your employees. The deduction is reduced by any credit claimed for premiums (the small employer health insurance credit is explained later).

Subtractions for personal expenses from gross income (called an above-the-line deduction). This category is for premiums to cover you as a self-employed individual or more-than-2% S corporation shareholder, as well as your spouse, your dependents, and children of yours up to age 26 that you include in your coverage.

Subtractions from adjusted gross income (an itemized deduction). This only applies to medical expenses that aren’t paid through insurance or withdrawals from medical-FSAs and health savings accounts.

Because the above-the-line deduction for self-employed individuals is a personal write-off and cannot be treated as a business expense, the amount of net earnings from self-employment is not reduced by medical costs for purposes of figuring self-employment tax. If Congress were to change the law and allow self-employed individuals to deduct their coverage as a business expense, it would effectively save more them than 15% of the cost.

Tax Credits

A tax credit is a subtraction from taxes you otherwise owe. Thus, each $1,000 of tax credit saves you $1,000 of taxes. There are two credits related to health coverage.

Individual Tax Credit

The premium tax credit can be claimed by eligible individuals who buy coverage through an exchange. This includes self-employed individuals; they are treated as individuals, not as small businesses, and must use the individual exchanges (not the exchanges for small businesses). Eligibility for this credit means:

Being between 133% and 400% of the federal poverty level (FPL).

Being ineligible for an employer or government plan.

Filing jointly (with some exceptions) if married.

Not being claimed as a dependent of another taxpayer.

The credit is refundable, which means that you get the benefit even if it’s more than your tax bill for the year. What’s more, it can be applied toward premium payments throughout the year; you don’t have to wait to file your return in order to benefit from the credit.

Business Tax Credit

There is a small employer health insurance credit for 2014 and 2015, which is 50% of the premiums you pay on behalf of your staff that is purchased through a government exchange called the Small Business Health Insurance Options Program (SHOPs). You must pay at least 50% of the premiums and you must meet some tricky and highly technical definitions for being a small business owner. You do not get this credit for coverage for yourself, spouse, dependent, and certain other relatives who work for you.

Government Subsidies

A government subsidy is a benefit you receive from the government; usually a government subsidy is tax free. This means it’s not included in income (it may need to be reported even though it won’t be taxed).

In the health care context, in addition to a tax credit to help cover premiums, some individuals may qualify for assistance with paying their deductibles, co-payments, co-insurance, and out-of-pocket spending limits. This government assistance is called cost-sharing subsidies. Cost-sharing subsidies are available for those who have a silver, gold, or platinum medical plan and whose income is between 100% and 250% of the FPL.

Conclusion

Still confused? Who wouldn’t be!

Check out IRS Publication 969 (PDF) to learn more about health care tax breaks. And talk with your tax advisor to see which breaks apply to you.

Barbara Weltman is an attorney and author of J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and is a trusted professional advocate for small businesses and entrepreneurs.

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